Shorting Oil, Hedging Tesla

[Dr. J]

'Tanker Tantrum' - How Crude's Record Contango Has Created "Greatest Trade In Decades"

Found this article discussing contango in the oil market, and how people are playing it. This is apparently the best of times for people buying oil and storing it for later delivery. And that translates into the best of times for people that own tankers.

The article also does some rounded math on the size of over production of oil for the next 2-4 months to get an idea of just how this 'wave' is going to play out shorter term, and then further out.


For those that haven't encountered the term contango before, the article also represents a very readable description of what it is, as well as how the big trading houses at least make use of it (hard for us as retail investors).

This is quite interesting. In the '00s, I made some decent money investing in tanker stocks, but they turned south years ago. I'm dipping my toe in again, specifically FRO and SFL. Not advice. These stocks trade like commodities, shipping rates are highly volatile, and there are more risks than I can list here. But I'm interested in hearing other viewpoints, especially contrary ones.

 

[adiggs]

That's all well and good, but we're still sitting at starting line if all this. What happens to crude pricing when Iran attacks a weakened Saudi royal family and starts a real war? Or what about when every US and Canadian small oil producer folds?

Remember.....we're on the other side of peak scarcity now. Up is down!

It seems to me like a pretty fundamental assumption of the contango trade described in that article, is that demand will be flat to up (maybe slightly down) over the next year or 5 (depends over what time period you're doing this trade over). The other half of this trade is that you sell today the oil you'll be delivering in 6 months or whatever time period you're going to deliver the oil. Which means you're shifting the problem of what the oil price will be in 6 months (or whatever) to the futures market. And today, the futures market is pricing in a big jump in the price of oil in 6 months (or whatever time period you care for).

What makes this trade work is that you can sell future oil today for a big premium over what you can buy physically delivered oil today. So much more that you can hire an oil tanker to load up and sit with 2M bbl oil for that 6 months, and then deliver the oil to the person that buys your future contract today.

The contango trader, as long as the counter parties don't go bankrupt, is getting risk free return.


So the answer to your question - that's all well and good, but what if ... The people playing the oil futures market are gonna get burned. Those people are buying future delivered oil at a big premium to today's oil. They're gonna be in big trouble if today's low prices are here to stay. Of course, they're betting that future oil, even at the elevated prices they're aiming for, is going to be even higher. Sounds like the fundamental market is changing, and the people playing in that market are still working off the old playbook for making money in oil

I hadn't really thought of this - the contango traders are selling future oil today. They're competing with producers of oil that want to hedge their future production. That looks like the makings of a crowded future trade to me. With so many sellers of future oil, that looks to me like those future prices are going to start coming down and get closer to oil delivered today.

 

[adiggs]

And that article also discusses why the people buying future oil at elevated prices might be right. In the short term, companies that aren't hedged will be supplying oil at really low prices. Those companies are headed for bankruptcy and the auction block.

That will take oil out of production (at least in theory), and lead to a constrained market at some point in the future which will push prices back up.


I think that point of view is wrong, at least in this dimension. I think that companies going out of business won't create a serious shortfall in production. Rather they will contribute to a more in-balance market that will sustain these low oil prices - not increase, but maybe stop the drop.

I also think that companies going bankrupt and auctioned off will lower production by a lot less than people think - the producing assets will be bought for pennies on the dollar (or less), and will be kept in production as the buyers now have effectively free oil. That'll continue down to $10/bbl and maybe lower.


It's a good time to be an energy consumer!

 

[TheTalkingMule]

I tend to agree there's absolutely no indication of supply balance, almost ever. But we have to believe market(and world) volatility is only going to increase from here. The disruption is just too great.

I've been making two very loud, semi-coherent ramblings in this thread for a couple years and both should play out in the near future:

1) As peak global crude demand approaches, the world(meaning all the money) is highly incentivized to unconsciously create a drastic disruption on the order of WWIII to maintain status quo.

So far it's looking like I may have been 180 degrees wrong on this one. Investor sentiment turned on a dime, big money's attitude toward most fossil investment soured, and(thanks be to Allah) TSLA investment dramatically increased. That doesn't mean the incentive isn't still there and all these players aren't now 10x more desperate and vulnerable. In other words, a 10-30M barrel supply disruption could still easily happen in one short sequence of events.

As a side note, I think this sentiment ended up manifesting itself in the form of our global reaction to coronavirus. But that's a conversation for July.

2) We have been and are in a global crude supply perma-glut.

Since early 2017, OPEC+ has been working in semi-coordination with Wall Street to keep crude pricing elevated even though global supplies have been at historically very high levels for the entirety. That coordination, both with investors and within OPEC, appears to have finally broken for good. There's no real avenue to anything other than massive oversupply through the end of oil as a fuel, other than something like a world war.

 

[Dr. J]

The contango trader, as long as the counter parties don't go bankrupt, is getting risk free return.

That he shares with the storage facility.

So the answer to your question - that's all well and good, but what if ... The people playing the oil futures market are gonna get burned.

Most likely, the storage facility gets paid anyway.

I am focusing on the storage facilities.

 

[adiggs]

That he shares with the storage facility.


Most likely, the storage facility gets paid anyway.

I am focusing on the storage facilities.

Yeah - if I were going to play this market, I'd be doing it through a company that owns oil tankers and get at this from the storage side. Sounds like tankers are going to be getting some really nice rates for awhile.

Last time I was dealing with shipping related companies, there were some pretty good dividend related plays available (which is what attracted me in the first place). From the point of view of that article, it sounds like there are going to be some really good days coming for the oil tanker storage market. Even old boats (maybe especially old boats) will be valuable in this market.

I personally don't plan to trade this. My energy to research another industry and company(s) is limited

 

[TheTalkingMule]

This is quite interesting. In the '00s, I made some decent money investing in tanker stocks, but they turned south years ago. I'm dipping my toe in again, specifically FRO and SFL. Not advice. These stocks trade like commodities, shipping rates are highly volatile, and there are more risks than I can list here. But I'm interested in hearing other viewpoints, especially contrary ones.

Well this got me reading. Wasn't all that interested in half learning more things I could screw up, but here we are!

So to me these were great buys at the recent trough and likely still are as a 2-3 year dividend pump as all this excess capacity attempts to unwind. Saudis bought a few boats off these guys shrinking the fleet a bit, but everything points to the coming few years as the best these guys have had in a long while.

Options are cheap, but it appears the value is in the dividend? Question is.....will this storage situation, which will certainly last years, keep daily ship rates elevated for the whole time?

I'm perfectly comfortable needing to know 6 months ahead of everyone else when global markets may re-balance, that's what this thread's for! Get in now and jump out if I ever sniff tightness on the horizon. If that never happens......US production is down 50% so the avg barrel of oil needs to travel farther AND we're still in a glut.

Edit: SFL($9.47 close, 52wk range $6.33 to $15.10) is showing call options @ $15 strike for a quarter. Why is that so cheap and FRO options seem to be 10x as expensive with not even double the market cap?

 

[jhm]

I think the article was referring to oil production rigs, not drilling

The shutdown of oil wells has already wiped out almost 1m barrels a day from global production, but the figure is expected to rise as producers run out of space to store their extra oil as the crisis continues.

Ok, I'll trying to be more aware of this distinction. I've been equating oil rigs with drilling activity. Do we have any info on what portion of rigs are not used for drilling?

 

[jhm]

Saudi Aramco considers $10B pipeline stake sale to raise cash

They've got $500B in cash, and about how much is easily liquidates assets?

The annual budget is about $300B, so we're pretty much in the window now. Any guesses when the royal family gets ousted?

In the midst of an oil price war and pandemic crushing demand, who's in the market to buy a $10B pipeline specifically from the Saudis? What price would anyone offer? $2B?

Oil companies including Aramco tend to have balance sheet assets that are petroleum based. So these can all lose value at the same time when the industry is in distress.

How this keeps the house of Saud in power, hmm.

 

[mspohr]

Ok, I'll trying to be more aware of this distinction. I've been equating oil rigs with drilling activity. Do we have any info on what portion of rigs are not used for drilling?

I think you and I equate rig with drilling but The Guardian is British and they have a different language.

 

[jhm]

It seems to me like a pretty fundamental assumption of the contango trade described in that article, is that demand will be flat to up (maybe slightly down) over the next year or 5 (depends over what time period you're doing this trade over). The other half of this trade is that you sell today the oil you'll be delivering in 6 months or whatever time period you're going to deliver the oil. Which means you're shifting the problem of what the oil price will be in 6 months (or whatever) to the futures market. And today, the futures market is pricing in a big jump in the price of oil in 6 months (or whatever time period you care for).

What makes this trade work is that you can sell future oil today for a big premium over what you can buy physically delivered oil today. So much more that you can hire an oil tanker to load up and sit with 2M bbl oil for that 6 months, and then deliver the oil to the person that buys your future contract today.

The contango trader, as long as the counter parties don't go bankrupt, is getting risk free return.


So the answer to your question - that's all well and good, but what if ... The people playing the oil futures market are gonna get burned. Those people are buying future delivered oil at a big premium to today's oil. They're gonna be in big trouble if today's low prices are here to stay. Of course, they're betting that future oil, even at the elevated prices they're aiming for, is going to be even higher. Sounds like the fundamental market is changing, and the people playing in that market are still working off the old playbook for making money in oil

I hadn't really thought of this - the contango traders are selling future oil today. They're competing with producers of oil that want to hedge their future production. That looks like the makings of a crowded future trade to me. With so many sellers of future oil, that looks to me like those future prices are going to start coming down and get closer to oil delivered today.

Contango induced storage helps oil producers to avoid lower prices at the beginning of a glut, but also keeps the prices down for a slow recovery from a glut. So it tends to extend a glut.

 

[jhm]

I tend to agree there's absolutely no indication of supply balance, almost ever. But we have to believe market(and world) volatility is only going to increase from here. The disruption is just too great.

I've been making two very loud, semi-coherent ramblings in this thread for a couple years and both should play out in the near future:

1) As peak global crude demand approaches, the world(meaning all the money) is highly incentivized to unconsciously create a drastic disruption on the order of WWIII to maintain status quo.

So far it's looking like I may have been 180 degrees wrong on this one. Investor sentiment turned on a dime, big money's attitude toward most fossil investment soured, and(thanks be to Allah) TSLA investment dramatically increased. That doesn't mean the incentive isn't still there and all these players aren't now 10x more desperate and vulnerable. In other words, a 10-30M barrel supply disruption could still easily happen in one short sequence of events.

As a side note, I think this sentiment ended up manifesting itself in the form of our global reaction to coronavirus. But that's a conversation for July.

2) We have been and are in a global crude supply perma-glut.

Since early 2017, OPEC+ has been working in semi-coordination with Wall Street to keep crude pricing elevated even though global supplies have been at historically very high levels for the entirety. That coordination, both with investors and within OPEC, appears to have finally broken for good. There's no real avenue to anything other than massive oversupply through the end of oil as a fuel, other than something like a world war.

Mule, you have a tendency to envision a hot war just around the corner at all times. Indeed the potential is always present. But I'd like to push you to think more about whether a hot war would actually improve the economics of oil. Increasingly the oil markets are becoming indifferent to supply disruption as a consequence of military attacks. Remember the strike against Saudi oilfields about half a year ago? Many market observers we disappointed the the oil markets just shrugged it off.

Part of the end of the age of oil is that it just is not as important as it once was. We should expect that as oil becomes less important, markets and economies will be more inclined to shrug off military threats to the oil supply. While this need not reduce the risks of war, it does mean that those who are deeply vested in oil can't benefit much from a war.

 

[jhm]

How Low Could U.S. Oil Production Actually Go? | OilPrice.com

This has some useful math on US shale rig productivity and decline rates.

I think the basic way that shale producer should play is to go dormant to conserve cash and talent for a later recovery. This implies that shale plays something close to a swing producer role. But the idea that the Saudis and Russians, suppressing prices for a period of time, will so damage shale that it won't spring right back up with prices is wishful thinking. It failed in 2014 and will fail again. A better attitude would be for the Saudis and Russians simply to compete on price, knowing that the moment there is an uptick in price there will be a production response from shale. This is a competitive market, period.

 

[Dr. J]

Options are cheap, but it appears the value is in the dividend? Question is.....will this storage situation, which will certainly last years, keep daily ship rates elevated for the whole time?

The dividends are large...until they aren't. Free cash flow, which feeds the dividend, is highly influenced by spot rates (which change daily) and average daily operating expenses for the fleet. Shipping rates are a function of shipping (and now storage) demand vs. available tankers. Tankers take a while to build, so short term changes in demand have an outsized effect on prices until new tankers are delivered or old tankers are retired, bringing back supply-demand balance. These are commodity logistics for commodities, so variability is high in everything that affects stock price. I suppose the opportunity lies in the fact that it's an under-researched area of the stock market.

Edit: SFL($9.47 close, 52wk range $6.33 to $15.10) is showing call options @ $15 strike for a quarter. Why is that so cheap and FRO options seem to be 10x as expensive with not even double the market cap?

I don't know, but SFL has a more diversified fleet including container ships, bulk carriers and drilling equipment, while FRO has a fleet AFAIK composed of different sized oil tankers.

From Reuters [note that this information may be out of date]:

[SFL Corporation] has a fleet of approximately 90 vessels, including tankers, bulkers, container vessels and offshore assets. Its oil tankers, chemical tankers and oil product tankers are all double-hull vessels. It has over nine asset types, including crude oil tankers, oil product tankers, chemical tankers, container vessels, car carriers, dry bulk carriers, jack-up drilling rigs, ultra-deepwater drilling units and offshore supply vessels. Its assets consist of a fleet of Suezmax tankers, crude carriers and oil/bulk/ore carriers.

From page 4 of Frontline's Q4 2019 presentation here:

As of December 31, 2019, the Company’s fleet consisted of 71 vessels, with an aggregate capacity of approximately 13.5 million DWT: (i) 48 vessels owned by the Company (14 VLCCs, 16 Suezmax tankers, 18 LR2/Aframax tankers); (ii) three VLCCs that are under finance leases; (iii) 10 Suezmax tankers to be acquired under the Sale and Purchase Agreement (the “SPA") with Trafigura Maritime Logistics (“TML”), a wholly owned subsidiary of Trafigura Group Pte Ltd. (“Trafigura”), five of which are currently recorded as finance leases and five of which will be recorded on closing of the Acquisition (as defined below); (iv) one VLCC that is recorded as an investment in finance lease; (v) two VLCCs chartered in from an unrelated third party; and (vi) seven vessels that are under the Company’s commercial management (three VLCCs, two Suezmax tankers, and two Aframax oil tankers).

Disclosure: since yesterday I am long FRO and SFL.

If this discussion is OT, I don't object to mods moving it elsewhere or starting up a new thread. Please hit disagree if you don't want to see this discussion.

 

[mspohr]

Will the coronavirus kill the oil industry and help save the climate?

Will the coronavirus kill the oil industry and help save the climate?

As for the impact of the virus on the timing [of peak demand], it depends of course on the severity,” he said. In 2018, Carbon Tracker estimated peak demand would come in 2023 but Bond said it was possible that the crisis has advanced this by three years. “That means that peak emissions was almost certainly 2019, and perhaps peak fossil fuels as well,” he said. “It will be touch and go if there can be another mini-peak in 2022, before the inexorable decline begins.”

Most strikingly, the fat rates of return projected for the oil and gas projects have slumped from about 20% down to 6%, she said. “They’re very much in line now with what you can get from solar and wind projects.”

Adrienne Buller, an economist at the Common Wealth thinktank, said governments in countries like the UK, US and Canada should now consider nationalising major oil corporations.

Experts, including Currie at Goldman Sachs, say the climate change debate will almost certainly take a difference course after the crisis. But exactly what that looks like remains to be seen. “The question is how long this is all going to last, and no one really knows,” said Kretzschmar.

 

[TheTalkingMule]

Whiting died this morning after a long battle with economics.

Whiting files for Chapter 11 bankruptcy as oil prices hover at $20

 

[adiggs]

Whiting died this morning after a long battle with economics.

Whiting files for Chapter 11 bankruptcy as oil prices hover at $20

It begins?

$15B market cap, down to $61M. So that's a 99.3% loss of market cap? I expect to see more like these as existing shareholders get wiped out (effectively), and bond holders take a big hit in order to keep companies operating.

(I learned yesterday that Chapter 11 is reorganization bankruptcy. You use that variant to keep the company operating and reorganize the financial structure).


I predict that Whiting, a company I've never heard of before, will be back. The next round might be another Ch 11 or it might be Ch7. If the next round isn't Ch 7, then the third round WILL be Ch 7.

Overall, I predict that'll be the pattern. First a reorganization, then possibly a second reorganization, and then an asset sale and dissolution.

 

[SmartElectric]

Adrienne Buller, an economist at the Common Wealth thinktank, said governments in countries like the UK, US and Canada should now consider nationalising major oil corporations

That Canada would ever again nationalize our Oil production needs to read history:
Government's tight grasp on Alberta oil: A short(ish) history - Macleans.ca

In 1973, Arab countries proclaimed an oil embargo on several western countries, quadrupling the world oil price and setting to boil the simmering Canadian worries its oil supply was too heavily under foreign control, primarily by U.S. firms. Pierre Trudeau’s government created Petro-Canada as a Crown corporation in 1975, and it expanded by snapping up private firms. The company was widely hated in the oil sector and Calgary; its red granite headquarters became known derisively as Red Square.

Oil is 30% of the economy in Alberta, 7% of the 3M jobs in Alberta, whereas the two largest provinces Ontario and Quebec have economies that are not based on Oil.

Economy of Alberta - Wikipedia

Canadian government bought an oil pipeline to attempt to increase access to water ports for the oil, but these ports are in the neighbouring province of B.C, which has significant environmental policies and high resistance to Alberta Oil. Note that B.C. has growth in natural gas exports, so it's not like they don't want to make money on fossil fuels, it's just that Alberta would be making the Oil profits, and B.C. taking the risks with over land pipeline and oil tankers in their waters. Why would B.C want that? Tip : they don't.

Alberta is land locked, high cost production, and I cannot fathom why Canadian government would nationalize. B.C would never allow the export anyway, it's not like Alberta hasn't be trying for decades to get more pipelines.

 

[TheTalkingMule]

I predict that Whiting, a company I've never heard of before, will be back. The next round might be another Ch 11 or it might be Ch7. If the next round isn't Ch 7, then the third round WILL be Ch 7.

Overall, I predict that'll be the pattern. First a reorganization, then possibly a second reorganization, and then an asset sale and dissolution.

This re-balancing of supply/demand is going to take so long there's really no timeline anyone can point to where this organization makes money. Most likely scenario is the big guys will pick their bones clean over the next 2 years. There's always hope within the oil majors that one or two large spikes in pricing are still out there and having shale capacity on the sidelines will be absurdly profitable. There's very little chance of that happening, but all indication are they believe it. XOM will be more than happy to pay 10 cents on the dollar for fracking assets.

 

[TheTalkingMule]

Mule, you have a tendency to envision a hot war just around the corner at all times. Indeed the potential is always present. But I'd like to push you to think more about whether a hot war would actually improve the economics of oil. Increasingly the oil markets are becoming indifferent to supply disruption as a consequence of military attacks. Remember the strike against Saudi oilfields about half a year ago? Many market observers we disappointed the the oil markets just shrugged it off.

I think of it like short interest in TSLA, there's a certain amount of pressure building that at some juncture must be released. My assumption had been a "hot world war" was inevitable as we approach peak oil demand, but my running theory is the coronavirus reaction is an equivalent amount of energy release directly related to the disruption of fossil fuels. Can't articulate it yet, but it feels right.

Part of the end of the age of oil is that it just is not as important as it once was. We should expect that as oil becomes less important, markets and economies will be more inclined to shrug off military threats to the oil supply. While this need not reduce the risks of war, it does mean that those who are deeply vested in oil can't benefit much from a war.

Obviously the decrease in fossil relevance is going to directly decrease all varieties of post-Vietnam warfare. Being a natural over-worrier, I guess I should have known this wouldn't be as dramatic as envisioned.

It's just hard to believe we're going to see the root of nearly all modern day global wealth simply fade away.